Look beyond valuation — this fund manager uses a unique strategy for returns that beat inflation

Published Thu, Jan 4 20246:58 PM EST

Hot inflation has been a global scourge in the past few years, and though it has cooled recently, consumers may not be out of the woods. What's happening at the moment may add to fears that inflation isn't going away: The crisis in the Red Sea is pushing ocean freight rates higher , triggering warnings of higher prices caused by supply chain pressures. One fund has a target of giving investors a return that is greater than the U.K. consumer price index plus another 3% — after fees and over any five-year period. That's the £2.27 billion ($2.88 billion) Rathbone Strategic Growth Portfolio, helmed by fund manager David Coombs. How it works The fund has a unique strategy. Rather than focusing only on either stocks or bonds, the fund has three parts to it: liquidity-type assets (forming 22.86% of the fund), equity-type risks (65.74%), and so-called diversifiers (11.4%). Liquidity-type assets: These are assets the firm expects will be easy to buy and sell during periods of market dislocation, and could be negatively correlated to stocks during such periods. Examples the fund holds include government bonds, high-quality credit and cash. Equity-type risk: Assets that can drive growth, including stocks; riskier corporate bonds such as high-yield debt; private equity funds; and alternative strategies such as hedge funds with a long bias. Diversifiers: These are assets that can reduce or offset equity risk when there's market distress, such as precious metals and other commodities, and actively managed fixed income. This is the allocation of the fund, as of Oct. 31 2023. Picking companies The fund's top stock holdings include some U.S. and global names such as Alphabet , Microsoft , ASML and Shell , as of Oct. 31. Buying growth stocks might be something that just about every other fund has done this year, Coombs acknowledged. But he stressed that his job is to beat inflation plus another 3%, and growth stocks are part of how it does the job. Having said that, Coombs does have some criteria towards picking his preferred type of companies. The fund's portfolio usually favors companies with less debt, higher profit margins and stronger growth rates than the average, according to Coombs. "You have to pay more to buy these sorts of assets, which is a risk, but we think they offer more security if a recession does arrive," he said. Such companies don't have "onerous" interest payments and they tend to have strong business models that should weather a recession and, crucially, not go bust, Coombs said. Valuation also isn't Coombs' most important metric when assessing stocks — contrary to the approach of many fund managers — although he does acknowledge its importance. Instead, he uses a metric called "return on capital employed." That's a ratio that looks at a company's profitability and how efficiently it puts its capital to use. While return on capital employed indicates how strong a company's business model is, valuations are a measure of how expensive or cheap the stock is — or a sign of investors' confidence or lack thereof — in the company. Since the fund was launched in June 2009, it has had a 143.47% return as of Oct. 2023 — exceeding the U.K. consumer price index, which rose 135.04%. This U.K. CPI number includes the 3% the company added to it as a target to beat. In the 12 months before September 2023, the fund returned 6.27%, below the U.K. consumer price index, which rose 9.86%, inclusive of the 3% the company added as a target to beat. In the past few years, the U.K. has experienced increases in consumer prices that exceed those in other parts of the world . Core inflation jumped to a record annual 7.1 % in May 2023 — the highest rate since March 1992 . In the same month, U.S. core inflation was up 5.3% from a year ago. Coombs has been at Rathbone since 2007. Before that, he was a fund manager at Baring Asset Management for about 18 years.